It's About to Get Harder to Seek Student Debt Relief

Students pull a "ball & chain" representing the $1.4 trillion outstanding student debt at Washington University in St. Louis on Oct. 9.

Photographer: Paul J. Richard/AFP via Getty Images

A new rule finalized Friday by the Obama administration will cost student debtors who say their colleges defrauded them some longstanding rights to get their federal loans canceled, while colleges on shaky financial footing dodged agovernment crackdown.

Those regulations, proposed in June, mark the administration's response to the spate of closures of for-profit colleges, following state and federal investigations and lawsuits that have so far led more than 80,000 Americans to seek debt relief, alleging fraud, according to new figures the U.S. Department of Education also released Friday.

According to a summary of the rule the agency provided late Thursday
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, borrowers who receive federal student loans starting next July and who subsequently accuse their colleges of misleading them into enrolling will face a narrower path to debt relief than today's borrowers.

If the rule is upheld, defrauded student debtors no longer will be able to get their loans canceled by alleging their schools violated state laws, unless they first successfully sue. Instead, they'll be subject to a new federal standard—one officials say is more efficient but consumer advocates say limits borrowers' ability to file claims.

The feds also barred colleges from forcing students seeking compensation into arbitration instead of going to court, a practice largely limited among colleges to the for-profit sector.

Already, the Education Department has agreed to cancel $247.4 million in debt owed by more than 15,000 former students of Corinthian Colleges Inc., the now-bankrupt chain that the department says marketed false job-placement statistics for dozens of its programs.

Experts expect the feds eventually will cancel billions in loans owed by students who attended various other schools, also.

The debt-cancellation provision has been on the books since the mid-1990s and has been disclosed in borrowers' federal loan contracts for years. But because it was little publicized—neither by the department's loan contractors nor by consumer advocates—few applied until last year, when a group of former Corinthian students refused to make payments on their loans to protest the agency's policing of for-profit colleges.

"As we know, there's plenty of reasons not to trust the Department of Education in making decisions in students' interests, so we're pretty skeptical about what this new process will look like in practice," said the activist group behind those "debt strikes"—first launched by former Corinthian students and later by ITT Educational Services Inc. students as well.

A flood of unexpected debt-relief applications swamped the department. State prosecutors and consumer advocates said it was ill-equipped to supervise the thousands of colleges that collectively get close to $100 billion a year in federal student loan funds, or to protect the millions of students who borrow from the feds to attend schools that, by participating in the loan program, effectively bear the government's seal of approval.

In response, the Obama administration vowed to rewrite the debt-cancellation rule, promising that colleges—not taxpayers—would shoulder the cost of all the discharged debt
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. But its proposal in June was panned both by colleges and by consumer advocacy organizations.

Colleges said the feds were proposing to penalize them for seemingly random financial issues they argued had no bearing on their ability to operate or cover the cost of eventual debt cancellations. Consumer groups said the department was trying to make it harder for borrowers to discharge their debt, accusing it of prioritizing limiting the potential cost over making defrauded borrowers whole.

Margaret Reiter, a former top California prosecutor who sued for-profit colleges, called the change to borrowers' debt-cancellation rights "shocking" in an Aug. 1 letter, given "the department’s abysmal track record in preventing national scandal time and again because of its failure to adequately police the student loan and grant programs."

Under the new rule, colleges that breach the government's list of triggers—such as a government lawsuit—typically will have to stump up a financial guarantee equal to 10 percent of their previous year's federal aid haul, unless the secretary of education determines the surety should be higher.

That provision is a retreat by the administration from its earlier, more expansive proposal, which would have subjected schools to potentially endless demands for more collateral each time they ran afoul of the government's triggers. Colleges had most objected to this element of the administration's proposal.

Apollo Education Group, owner of the giant University of Phoenix, told investors this year that surety demands in excess of 10 percent could scuttle its planned sale of the school to a group of private equity buyers that includes Tony Miller, chief operating officer of the Vistria Group and a former deputy education secretary under the Obama administration.